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U.S. Department of Justice

VOICE, VIDEO AND/ /

BROADBAND://

THE CHANGING//

COMPETITIVE LANDSCAPE AND/ /

ITS IMPACT ON CONSUMERS//U.S. DEPARTMENT OF JUSTICE//

NOVEMBER 2008

VOICE, VIDEO AND BROADBAND:

THE CHANGING COMPETITIVE LANDSCAPE

AND

ITS IMPACT ON CONSUMERS

ISSUED BY THE

U.S. DEPARTMENT OF JUSTICE

NOVEMBER 2008

This report should be cited as:

U.S. Dep't of Justice, Voice, Video and Broadband: The Changing Competitive Landscape and

Its Impact on Consumers (November 2008).

This report can be accessed electronically at:

U.S.

DEPARTMENT OF JUSTICE

ANTITRUST DIVISION

THOMAS O. BARNETT

Assistant Attorney General

Deborah A. Garza

Deputy Assistant Attorney General for Regulatory Matters

Ken Heyer

Acting Deputy Assistant Attorney General for Economic Analysis and Economics Director of Enforcement

David L. Meyer

Deputy Assistant Attorney General for Civil Enforcement

James J. O'Connell, Jr.

Deputy Assistant Attorney General for International, Policy and

Appellate Matters

J. Robert Kramer, II Director of Operations

Patricia A. Brink Deputy Director of Operations

R

EPORT CONTRIBUTORS:

Anne Marie Cushmac Counsel to the Assistant Attorney General W. Robert Majure Chief, Competition Policy Section Jonathan E. Henly Economist, Competition Policy Section

Robert A. Potter Chief, Legal Policy Section

Nancy M. Goodman Chief, Telecommunications and Media Section Laury E. Bobbish Assistant Chief, Telecommunications and Media Section Hillary B. Burchuk Trial Attorney, Telecommunications and Media Section Luin P. Fitch Trial Attorney, Telecommunications and Media Section Lawrence M. Frankel Trial Attorney, Telecommunications and Media Section Matthew C. Hammond Trial Attorney, Telecommunications and Media Section Brian C. Hill Trial Attorney, Telecommunications and Media Section Deborah A. Roy Trial Attorney, Telecommunications and Media Section Yvette Tarlov Trial Attorney, Telecommunications and Media Section Carl Willner Trial Attorney, Telecommunications and Media Section Drew Austria Paralegal, Telecommunications and Media Section Ashley Becker Paralegal, Telecommunications and Media Section Gabriel Borman Paralegal, Telecommunications and Media Section Ryan Shallard Paralegal, Telecommunications and Media Section Inquiries concerning this report should be directed to: Nancy M. Goodman, Chief, Telecommunications and Media Section (202)

514-5621 or

2007TelecomSymposium@usdoj.gov

ACKNOWLEDGMENTS

The Department of Justice thanks the speakers who participated in the Symposium and all those who submitted written comments for their thoughtful and informed contributions. The Department especially recognizes the contribution of the late Honorable Jane Lawton as a speaker at the Symposium. Delegate Lawton was a dedicated public servant who demonstrated exemplary energy and commitment to the development and implementation of sound public policy.

TABLE OF CONTENTS

EXECUTIVE SUMMARY .................................................... i INTRODUCTION ............................................................1 CHAPTER I: OVERVIEW OF SECTORS AND PARTICIPANTS ..........................5 A. Video Programming Delivery Services ................................................... 5 B. Local Telephone Services ............................................................. 9 C. Broadband Services ................................................................. 19

1. Wireless Providers ............................................................... 23

2. Satellite Providers ............................................................... 26

3. Broadband over Power Line ...................................................... 28

CHAPTER II: THE EFFECTS OF COMPETITIVE ENTRY ............................ 31

A. Economic Principles Affecting Facilities-Based Telecommunications Competition ................ 31

1. The Classic Model of High Sunk-Cost Industries ....................................... 31

2. Sources of Competition: Deviations from the Sunk-Cost Model ........................... 32

3. Regulation and Other Factors that Can Lead to Imperfect Competition....................... 34

B. Consumer Benefits from Competition in Video and Local Telephony ........................... 35

1. Price Effects of Competition ....................................................... 37

a. Video ..................................................................... 37 b. Telephony .................................................................. 42 c. Bundled Services Pricing ...................................................... 42

2. Non-Price Effects of Competition ................................................... 45

C. Challenges Faced by New Broadband Providers ........................................... 49 D. The Competitive Importance of Service Bundles ........................................... 54 E. Wireless Substitution for Wireline Telecommunications Services .............................. 61 CHAPTER III: OBSTACLES TO COMPETITIVE ENTRY ............................. 69 A. MVPD Services .................................................................... 69

1. Local Franchising Requirements .................................................... 69

2. Access to Multiple Dwelling Units .................................................. 73

3. Access to "Must-Have" Programming ................................................ 74

B. Local Telephone Services ............................................................. 77

1. Forbearance Proceedings and Requests to Deregulate Local Services ....................... 77

2. Access to Customers in Multiple Dwelling Situations .................................... 79

C. Broadband Providers ................................................................. 80

1. Spectrum Policies ............................................................... 81

2. Other Regulatory Issues Affecting Broadband Deployment ............................... 82

3. Prices for Local Private Lines ...................................................... 84

CHAPTER IV: OBSERVATIONS AND CONCLUSIONS FOR COMPETITION POLICY ........ 87 A. General Competitive Trends ........................................................... 87 B. Barriers to Entry .................................................................... 88 C. Proposals for Further Action ........................................................... 90 APPENDIX A: GLOSSARY OF TERMS USED IN THE REPORT ....................... A-1 APPENDIX B: SYMPOSIUM PARTICIPANTS ..................................... B-1 APPENDIX C: WRITTEN SUBMISSIONS ........................................ C-1 APPENDIX D: THE EVOLUTION OF WIRELESS TECHNOLOGY ...................... D-1

EXECUTIVE SUMMARY

Increasing competition in the telecommunications industry has produced substantial benefits for consumers, and has the potential to generate even greater benefits in the futu re. Companies that once provided voice telephony or video services alone are inc reasingly competing against each other across a wide variety of products. Cable companies today offer telephone services to more than 100 million U.S. households (or over 80 percent of households) and have upgraded their facilities to increase Internet broadband speeds and provide a wider array of programming. At the same time, telephone companies are rapidly building and expanding fiber-optic networks to provide a wide range of services to an increasing number of customers, including multichannel video programming and increasingly robust Internet access. In addition, competition among providers of mobile wireless voice and data services is resulting in rapidly rising access speeds, dramatically expanding the functionality of mobile devices, and potentially altering the future competitive dynamic between wireless and wireline services. As telecommunications firms expand their offerings, lines between once well-delineated industry segments blur, and consumers see greater competitive options. Antitrust will continue to play an important role in this process. Antitrust law protects the competitive process, which in turn protects consumers. In the telecommunications industry, the competitive process has helped generate innovation to bring consumers a wider range of choices of products and services. The Department of Justice protects competition through its roles as both enforcer of the antitrust laws and advocate for sound competition policy. The Department's competition advocacy is particularly important in the telecommunications industry, where government regulations significantly shape the competitive landscape. To enhance its ability to fulfill those responsibilities, in November 2007 the Department hosted a Symposium focusing on competition among providers of video programming delivery, local telephony, and broadband services. Industry executives, economists, analysts, and local government officials participated at the Symposium and through written submissions, offering a variety of perspectives. This report summarizes their views. Chapter I provides an overview of developments in the three industry segments addressed at the Symposium - video, telephony, and broadband. The most significant development in video programming delivery is entry by telephone companies seeking to compete with cable and direct broadcast satellite providers. Trends in local telephony include a decline in the number of residential landlines, primarily as a result of consumers discontinuing second lines, and entry by cable firms. Broadband services have experienced explosive growth. The number of homes receiving broadband services increased twenty-fold between 2000 and 2007 . Symposium participants expected continued growth and competition among telephone providers, cable companies, and other technologies, including wireless services. Following an overview of economic principles affecting telecommunications competition, Chapter II addresses the competitive effects of the industry's changing dynamics. There was broad consensus at the Symposium that competition provides consumers with significantly more choice today than they have had in the past: more providers, greater variety i in video entertainment, and a wider selection of devices to access the Internet. Participa nts addressed challenges faced by new broadband entrants and technologies an d other issues important to competition in telecommunications, including the competitive effects of bundled discounting (the practice of offering a bundle of services at a price l ower than the combined price at which each item in the bundle is offered on a stand-alone basis), the degree of competition between wireline and wireless telephone services, and the effect of new competition on price. Chapter III discusses potential obstacles to entry. Poorly designed regulations have the potential to deter entry and harm consumers. Symposium participants discussed specific regulatory issues affecting each of the three segments, as well as whether conduct by incumbent providers is deterring entry. Chapter IV discusses the Department's future competition advocacy and enforcement activities. Mergers, unilateral conduct, and concerted action in the telecommunications industry all can raise competitive concern, and the Department remains committed to monitoring the industry vigilantly, investigating alleged antitrust violations, and enf orcing the antitrust laws against anticompetitive practices harming consumers. In its enforcement decisions, the Department will continue to rely on evidence of actual market conditions and take into account changing industry dynamics. The report concludes with several proposals for further action:

In assessing the legality of conduct in the telecommunications industry under the antitrust laws, the Department will continue to give particular attention to the effects of convergence and increasing substitution among services.

To aid its ability to enforce the antitrust laws in the telecommunications industry efficiently and effectively, the Department will continue to monitor industry trends and developments. Because effective review requires reliable data, however, the Department recommends that regulators review and, where appropriate, improve the way they collect and report data to capture the effect of changes that a

re blurring lines between formerly distinct industry sectors.

Increased efforts to obtain relevant data and further refine economic analysis would advance the Department's ability to evaluate competitive conditions. Potential subjects of future study include review of the competitive implications of bundled pricing, substitution patterns, and quality-adjusted pricing trends.

In its role as advocate for sound competition policy, the Department will continue to seek the removal of regulatory barriers that unreasonably impede competition.

The Symposium advanced the Department's understanding of the complex competitive forces at work in the telecommunications industry, furthering its ability to make sound, pro- consumer enforcement decisions and to fulfill its duty to advocate sound competition policy more effectively. The Department also hopes that this report will serve as a valuable reference. ii

INTRODUCTION

Telecommunications services

1 which allow consumers to communicate through traditional voice conversations and by sending and receiving data and ot her information, including video, from an ever-widening array of sources are a critical component of the U.S. economy. The telecommunications industry has experienced significant technological, economic, and regulatory changes since the breakup of the Bell System in 1984 2 and passage of the Telecommunications Act of 1996 (“1996 Act"). 3

Many of these changes have been

beneficial for consumers and competition. Technological development has increased rivalry among providers of traditional telephone and video services, while also br inging widespread access to more advanced telecommunications services (such as mobile data and broadband Internet access). Cable television providers now offer residential voice telephone service s throughout much of the United States, and some telephone carriers have begun to compete with incumbent cable systems and satellite-based providers in the delivery of multichannel video programming. There is also widespread discussion of other possible alternatives for the delivery of broadband to consumers, including use of mobile and fixed wireless services 4 and broadband over power line. Moreover, voice telephony, broadband, and multichannel video programming are frequently being offered to consumers as bundles, often at discounts from stand-alone service prices. In the decade since the passage of the 1996 Act, federal laws and govern ment policy increasingly have favored the provision of telephone services and delivery of multichannel video programming on a competitive basis, which generally represents the best method of ensuring that consumers receive low-priced, high-quality products and services, greater choice among providers, and continuing innovation. However, not all consumers have access to competitive alternatives, nor are all benefitting from new technologies or the entry of new providers. Concerns have been expressed about remaining barriers to entry into the delivery of telecommunications services. Such barriers - whether arising from regulatory restrictions, the 1

In this report, the term “telecommunications" encompasses voice telephone services, services providing

multiple channels of video programming such as cable television, and high speed data services that are commonly

referred to as “broadband." A glossary of technical terms used in this report is provided in Appendix A.

2 See United States v. American Telephone & Telegraph Co., 552 F. Supp. 131 (D.D.C. 1982), aff'd sub nom. Maryland v. United States, 460 U.S. 1001 (1983). 3

Telecommunications Act of 1996, Pub. L. No. 104-104, 110 Stat. 56 (1996), codified at 47 U.S.C. § 151

et seq. 4 “Wireless" services are delivered to the customer using radio spectrum: electromagnetic waves

propagated through space on specific frequencies. This spectrum is used in various forms of communications,

including with cellular telephones and other wireless devices as well as in television and radio broadcasting.

“Fixed" wireless refers to technologies that are limited to serving a customer at a particular location, while “mobile"

wireless refers to technologies that a customer can continue to use while moving about, such as cellular telephone

technology. In contrast, “wireline" or “landline" services (these terms are used in the report interchangeably)

connect to the customer by physical means (such as a copper loop, coaxial cable or fiber) and are by definition fixed,

since the wireline cannot follow a moving customer. 1 conduct of established providers, or inherent economic and technical limitations - may tend to restrict the number of competitors for these services. To better understand these issues and help inform its enforcement efforts, in November

2007 the Department hosted a public Symposium in Washington, D.C.

5

The Symposium

covered a wide range of topics, such as the impact of convergence among traditionally distinct lines of activity (such as video delivery, landline telephony, and wire less services), the competitive importance of service bundles, and the existence of regulatory and other o bstacles to competitive entry. Participants included industry executives, economists, analysts, representatives of industry associations, and local government officials. 6

In addition, the

Department requested and received comments from the business community and other interested parties. 7 One objective of the Symposium was to enable industry participants to present information about developments in the industry that could impact future enforcement decisions and/or competition policies. The Department analyzes mergers using the framework outlined in the

Horizontal Merger Guidelines

8 which provide a methodology for defining relevant product and geographic markets. In past merger investigations involving telecommunications services, the Department concluded that services deliv ered by wireless technologies were not close economic substitutes for wireline services 9 and that some types of telecommunications services (such as local, long distance, and international telephony) were separ ate product markets 10 even though they might be marketed to consumers in a package. In addition, many geographic markets have been defined to be local, as opposed to national or regional 11

Because of the

rapidly changing telecommunications landscape, including the advent of new technologies and services, expansion by existing providers into new geographic areas and services, and changes in 5 The Symposium record, including agenda, presentations, and written submissions, is available on the Department's website at http://www.usdoj.gov/atr/public/hearings/telecom2007/index.htm. 6

A list of the participants in the hearings, along with their affiliations at the time of their participation, is

provided in Appendix B. 7 A list of the entities that submitted written comments is provided in Appendix C. 8 U.S. Dep"t of Justice & Fed. Trade Comm"n, Horizontal Merger Guidelines (rev. ed. Apr. 8, 1997) ("Horizontal Merger Guidelines"), available at http://www.usdoj.gov/atr/public/guidelines/hmg.pdf. 9

2000) (alleging wireless phones are not a close substitute for long distance calls originating from wireline phones).

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